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By Dan Strumpf and Newley Purnell 

HONG KONG--In the five years since ZTE Corp. was branded a national-security threat by U.S. lawmakers, the Chinese telecommunications giant has quietly been building its own American success story.

While locked out of the market for networking technology, ZTE has grown its smartphone business, which is now the fourth largest among U.S. consumers. Last year alone the Shenzhen-based company almost doubled its market share to 11.2%, selling 19 million handsets and making the country its biggest market, according to research firm Canalys.

Now, ZTE executives are grappling with a new roadblock that they say threatens the company's very survival. The U.S. government moved on Monday to block sales of American products to ZTE, saying the company violated the terms of a deal last year settling allegations of sanctions-busting involving North Korea and Iran.

The ban has forced the Chinese telecom titan to assess whether it must--or even can--replace key components such as semiconductors supplied by Qualcomm Inc. and the Android mobile operating system it uses, made by Alphabet Inc.'s Google.

ZTE shot back at the U.S. in a statement on Friday calling the Commerce Department order "unacceptable," and saying it will "not only severely impact the survival and development of ZTE, but will also cause damages to all partners of ZTE including a large number of U.S. companies."

"This is a body blow to them," said Duncan Clark, chairman of BDA China, a Beijing-based consulting firm that specializes in technology. "It's sort of hitting at a homegrown hero."

Qualcomm and Google declined to comment.

ZTE is the latest company to be caught in the crosshairs of an increasingly rancorous trade dispute between China and the U.S. that is placing increasing emphasis on the technological race between the countries amid heightened national-security concerns. The sales ban is likely to accelerate China's efforts to develop its own technology supply chain and wean the country off imports from U.S. companies--a feat viewed by some officials in Washington as an even more worrying long-term threat to American interests.

The U.S. Commerce Department's announcement of a seven-year ban on sales of U.S. parts and software to ZTE has cast a renewed spotlight on China's telecoms firms. ZTE and its bigger and better-known rival, Huawei Technologies Co., were the subject of a 2012 investigation by the U.S. House Intelligence Committee that recommended American telecom operators not use gear from those companies in building cellular networks, citing national security risks. Both ZTE and Huawei have long denied that their products pose a security threat.

Among the issues singled out by the House report was the ownership structures of the two companies. Huawei is privately held and owned by its employees. By contrast, ZTE, founded by five Chinese engineers in the 1980s, is publicly traded on stock exchanges in Shenzhen and Hong Kong and regularly discloses quarterly earnings.

That transparency earned ZTE softer treatment than Huawei. However, the House report still singled out the state ties of its largest investor, which today holds 30% of the company, according to public records. ZTE has said the state-owned investor isn't involved in any direct or indirect decision-making at the company.

The 2012 report set Huawei and ZTE on dual paths, with Huawei focusing on expanding outside the U.S., and ZTE nurturing its existing ties with U.S. mobile-phone operators to expand its market share there. To grow its U.S. business, ZTE opened five research and development centers in the country, upped its spending on Washington lobbying and now sponsors NBA teams like the Houston Rockets, the New York Knicks and the Golden State Warriors.

The result: Huawei now dominates the global telecom landscape virtually everywhere except the U.S., while ZTE commands a sizable share of the coveted U.S. smartphone market, which Huawei has failed to crack, though ZTE is an also-ran globally. Last year, ZTE unveiled a new flagship phone, a foldable handset called the Axon M that retails for $725 via AT&T Inc. in the U.S.

ZTE has delayed its first-quarter earnings, which were set to be released Thursday, to weigh how the Commerce Department order will affect its business.

The sanctions could hamper ZTE's ability to make and sell products world-wide--and thus help its rivals, which include Huawei, Finland's Nokia Corp. and Sweden's Ericsson AB.

ZTE's woes might not end up helping Ericsson or Nokia, which generally sell more expensive equipment, said Roger Entner of Recon Analytics. Instead, it might help Huawei, which also sells lower-priced electronics. "If you're shopping for a Kia, you're not going to upgrade to a BMW," he said.

In 2017, Huawei led with a 27% share of the global telecom-equipment market, followed by Nokia at 17% and Ericsson at 13%, according to research-firm Dell'Oro Group. ZTE was fourth with 10%. But in the U.S., Ericsson and Nokia each held a 48% market share, while Huawei and ZTE had less than 1%.

Spokesmen for Ericsson and Nokia declined to comment.

In its home market of China, ZTE is a small player in smartphones but has grown into a major supplier of networking equipment like cell towers and routers. Backed by the Chinese government as a tech national champion, it works alongside Huawei in the race to develop next-generation 5G wireless technology, a competitive area in which Qualcomm is seen by U.S. officials as a crucial competitor. ZTE sent 11 representatives to an industry-sponsored meeting last month in the Indian city of Chennai to discuss 5G specifications, according to conference records.

International trade experts called the U.S. sales ban wide-ranging, affecting not just exported items, but also software and components marketed by American companies but manufactured in other parts of the world.

That would include a broad slate of hardware critical to ZTE, including Qualcomm semiconductors. It also potentially covers software like the Android operating system, which powers ZTE smartphones. ZTE is working to find ways to preserve its access to Android, according to a person familiar with the matter.

"If they're unable to use Google Android, I think that's a big blow because there's no real viable alternative at this point," said Neil Shah, an analyst with research firm Counterpoint.

Without access to parts from U.S. companies needed for its networking gear, ZTE will have a tough time selling its products and being competitive in the rollout of 5G equipment, said Edison Lee, a telecom analyst at Jefferies.

"If this ban really continues and the U.S. really enforces it, I think ZTE is in big trouble," he said.

Write to Dan Strumpf at daniel.strumpf@wsj.com and Newley Purnell at newley.purnell @wsj.com

(END) Dow Jones Newswires

April 20, 2018 05:44 ET (09:44 GMT)

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